Social networks are plenty and in past few years they have grown both horizontally from dynamic user groups to platforms and vertically from social networks for gays and lesbians to invitation only groups for social elites.

Social networks are hugely succesful in India too. According to latest data from camScore indian social networks have grown 50 % in the year 2007-08. Moreover majority of web users are now social networkers.

But despite this phenomenal adaptation of SNs idea , social networks are loosing more money then they make for their investors.

This post is my attempt to understand the whole social network monetisation problems and related issues.

Social networks are used as marketing and branding media and make money through advertising same way as TV, Radio, Newspaper does. This way advertisiding drives the form and functions of social networks. Social networks have to cater needs of two different parties, the actual user, who want to use them as they wish to with minimum interference from anyone incling owners and advertiser who pay for runing the show and what users to behave in curtain way. This create a disconnect between interest of parties involved and there a contest going on between user and advertisers where social network trying to balance the needs of both parties.

Social network are new kind of media in advertising industry and do not enjoy same level acceptence and trust among media buyers as enjoyed by TV & newspapers. They are yet to prove their effectiveness and metrics used to evaluate thier effectiveness are evolving.

Other challenges involoved in monetizsing are related to very nature of social network. For exampl most of the network rely on user generated content where social network have very limited freedom to play with content. Most of the user activities are action oriented like writing on wall, poking friends, sending sms and hence provided little space for text/display adversting model. Users are agnostic to any significant changes in social network structure and forms done to suit the needs and requirements of advertisers. Attempts to sell/use user information to third party resulted in backlashs and there is increasing awareness among users about privacy related issues. Many user privacy watchdogs are seeking change in privacy policies of social networks.

Below is more detailed analysis of two major issues related to monetisation of Social networks.

1. Low CPM or Unsuitable metrics – CPM may not be the best indicator of social network analysis

Lookery, an ad network specializing in social media, offers display ads on MySpace, Facebook, and Bebo for only 13 cents per thousand times the ad is served (CPM); Yahoo’s average CPM is estimated at $13. Video ads on MySpace reportedly fetch just $25 per thousand showings; CBS charges $50 on affiliated sites, NBC as much as $75. (Source)

Next question will be is why SN have low CPM . The reason is that most social network reply soley on advertising revenue.

Regardless of the model (CPM, CPC, CPA), advertisers value three key measures: reach, frequency, and targeting. Many social media sites certainly score high on reach and frequency, but how do they fare on targeting? Targeting is key, because it determines the CPM rates advertisers are willing to pay. And CPM rates vary very widely: from $16-20 for TripAdvisor to $0.10 for Facebook and MySpace. See, for example, this media plan. (Source)

There is another dimention to low CPM for social networks which is quite counterintutive.

The assumption is that if users are worth money, then more users are worth more money. Theoretically, an infinite number of users are worth an infinite amount of money. Itâ€™s simply not true.

There is a point of diminishing returns in Web advertising. Enormous traffic creates a glut of inventory, which inevitably drives the value of ads down. The most highly valued inventory on the Web is branded, high-quality media content. Itâ€™s valuable because the content projects value onto the advertiser. When Target advertises on MTV.com, the brand benefits from MTVâ€™s youth-oriented content, giving the brand a youthful shine. In contrast, utility inventory lacks the compelling context that advertisers need to help build identity and image, and in many cases may include negative images. The result is that advertisers have no cause to align their brands with products like Social Networks. Unlimited inventory and negative brand association is a perfect storm for low CPMs.(Source)

Extra : Here is interesting explanations and maths that is involved in calcauting CPM

2. User behaviour

Both social network & advertsier would like to use datamining techniews to target there advertsing to improve their CPM . But this leds to problems related to privacy fo user information . User behaviour give different challenges to social network. On social networks, people are primarily concerned with communicating with their friends, not looking to buy items or services. Moreover when marketers try to shake things up, users don’t take kindly to major changes. There are issues related to trust and privacy of user infomation and this lack of trust is mutual.

the fundamental problem that social networks face when trying to monetize through an advertising-driven business model is the lack of trust. To be more explicit, while brand advertisers have historically trusted people as consumers, they do not trust them in the new role of producer (e.g. uncontrollable content). Likewise, people who are armed with the power of interactivity are also demonstrating that they are increasingly distrustful of brand advertisers (e.g. ad-skipping).(Source)

I come across few exellent presentations related to subject. Here are two of them

In the next post I will look for solutions that are been tried to resolve problems mentions above and will do some analysis on how successful are they in generating revenue for companies. I would also like to cover indian social networks are trying to resolve monetization conundrum

And the list goes on (feedburner,flickr,blogger etc). Valuation of a start-up is a complex process.It become even more complex when you have to deal with unreliable data,unproven bussiness models and mix of noise and hype.Unfortunely in case of web 2.0 companies we have to deal with these issues making valuation of SN very mysterious.

Ok.Then how did we reached to numbers these numbers.? What factor affect valuation? How objective is the process?

I made a attempt to find answers to these questions by looking in to stories,news,blogs and follwoing comments around the most talked about startups of the world.

“You have little data on what kind of revenues they can generate and what their cost structure is.”

“Valuing advertising-driven sites is particularly hard because the same numbers — such as the number of users or page views — can mean different things depending on how the advertisers are billed”

“But is Google a good benchmark? ”

Analysts also like to factor in a company’s future prospects, using any number of calculations to derive a figure for “discounted cash flow.” Essentially, they look at expected revenues over a given number of years and subtract expenses to arrive at a figure for “free cash flow.” Then, using various assumptions about interest rates, they determine what money received in the future is worth in today’s terms. Analysts can never be sure about any company’s future revenues and expenses, but the problem is even worse when dealing with a young company in a fledgling industry. “

“How much yearly profit would you expect from a $500 million purchase? How about a profit of just $10 million equating to a profit margin just under 2%. That’s right, the world’s largest social networking site, constantly in the top 10 web sites in the world, managed to make only $10 million on $550 million in revenue!”

This seems to be a highly objective process which include a multiplier for everything from size of market,stage of start-up,revenue,indusrty etc.But I doubt we can use this in case of SNs as calculation of multipiler is still a issue whihc is based on past history of industry,market,product and team.And yes ,we do have a fair amount of subjectivity here.

Gary Rivlin at the New York Times his written great piece on Friendster. This could be considered as best overview yet of the terrific bungle of social networking company,which sparked the social networking revolution by allowing friends to hook up with others.

It is a great tale of how Jonathan Abrams started the site as a way to get a few dates, turned down a $30M buyout offer from Google (which would be worth around $1B in GOOG stock today), and opted to raise VC money from John Doerr of Kleiner Perkins and Bob Kagle of Benchmark — trying to create the next big thing.

Friendster had everything a “dream Start-up” seek.Great idea, first mover advantage, was backed by best VCs the in market.All this failed to make Friendster a “success “.

Friendster story tells us many thing us we should do as well as few we should we should not do.It tell us about role managment team play in success of a venture.It tell us how important its that we use and believe in the product we create.Focus is crucial as we grow and CEO and managment arrogance can kill grand product in no time.

Friendster make a great case study for all aspiring WEB 2.0 enterpreneurs as we all know failure store more lessons for us then a success.

Here is a interesting discussion about Friendster story on Techcrunch.

Information Architects has released their 2nd Web Trends Map Awesome collection of all the visible web brands especially Web 2.0, marked according to their category, proximity, success, popularity and perspective.

HOT or NOT is one of the well known startup success story in Silicon Valley.The founders of this company have scaled it to a level where they are pulling 4 million + a year in revenue.I doubt if even well known Indian startups are making this much money.

I was reading James Hong’s blog, one of the founders, where share his knowldge and wisdom that may inspire you as an entrepreneur.

Here is his thoughts on hiring and motivationg staff

“So you go out and get the smartest guys you can. But because you know these brilliant people are not going to want to stick around (especially because they see how much work they are doing, how much work you are doing, how much money they are making, and how much money you are making..). So you realize that compensation structure becomes a REALLY big issue. Even Andrew has had problems with this issue, despite the fact that he is probably (presumably) able to pay someone millions of dollars per year in cash compensation to do a good job of running his company.And that is the natural, first-instinct way to address the problem. “Well, maybe we can pay them more to make them happy.”

It never works. At least not here in Silicon Valley. Engineers at HOTorNOT last year were making 2-3x normal salaries, yet they were not happy… and we really couldn’t expect them to be. After all, the only people we trusted with our baby were people like us.. and god knows I wouldn’t have stayed here for a high salary. At their age (23), I wanted risk and potential reward, not a steady job. I make a big deal of telling people that when I finished my MBA at 25, I turned down a job that was gonna pay me about $180k in the first year.. despite the fact that I was $50k in debt.. to instead earn no paycheck and give entrepreneurship a go. These are the type of people you trust to continue running your site in “high profit margin” mode. Big company types won’t do.“